Home Buyers Warranty Corporation v. Lois Hanna , 750 F.3d 427 ( 2014 )

PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
No. 13-1834
HOME BUYERS WARRANTY CORPORATION, a Colorado corporation;
NATIONAL HOME INSURANCE COMPANY (a Risk Retention Group), a
Colorado corporation; NEW HOME WARRANTY INSURANCE COMPANY (a
Risk Retention Group), a Colorado corporation,
Petitioners – Appellants,
v.
LOIS HANNA,
Respondent – Appellee.
Appeal from the United States District Court for the Southern
District of West Virginia, at Charleston. Joseph R. Goodwin,
District Judge. (2:13-cv-01859)
Argued: March 18, 2014 Decided: April 29, 2014
Before WILKINSON, MOTZ, and DIAZ, Circuit Judges.
Remanded with directions by published opinion. Judge Wilkinson
wrote the opinion, in which Judge Motz and Judge Diaz joined.
ARGUED: Carlos Victor Yguico, GEMMILL BALDRIDGE & YGUICO, Los
Angeles, California, for Appellants. Christopher Brinkley,
MASTERS LAW FIRM, LC, Charleston, West Virginia, for Appellee.
ON BRIEF: James W. Marshall, BAILEY & WYANT, PLLC, Charleston,
West Virginia, for Appellants.
WILKINSON, Circuit Judge:
Lois Hanna filed a lawsuit in state court against multiple
defendants alleging various construction defects in her recently
completed home. Petitioners are a subset of defendants in the
state court suit because of a warranty they issued on Hanna’s
home. They subsequently filed in federal district court a
petition to compel Hanna to arbitrate her claims against them
based on an arbitration clause in the warranty. Petitioners
predicated subject matter jurisdiction on complete diversity of
the parties under 28 U.S.C. § 1332. Hanna argues that
petitioners failed to join necessary and indispensable parties,
some of which are non-diverse from Hanna, under Rule 19 of the
Federal Rules of Civil Procedure. We agree, and remand to the
district court with directions to dismiss the petition for want
of subject matter jurisdiction.
I.
A.
On August 1, 2009, Hanna signed a contract with Clark
Lamp II and Innovative Design & Construction, LLC
(“Innovative”), for the construction of a new home. Lamp
provided Hanna with a Builder’s Warranty and Certificate
(“Builder’s Warranty”) that covered workmanship and materials
for one year, mechanical systems and appliances for two years,
2
and the structure of the house for ten years. The Builder’s
Warranty named Lamp as the “Warrantor,” but it did not indicate
that he would enroll Hanna’s house in a warranty offered by a
third party, nor did it authorize him to take such an action.
It also provided that:
This Warranty shall be in addition to, and in no way
reduce, all other rights and privileges which Owners
may have in law or in equity or under any other
instrument, and shall be binding on the Warrantor
notwithstanding any provision to the contrary
contained in the contract of purchase or any other
instrument executed by the Owners.
J.A. 136. Lamp, Innovative, and several subcontractors and
engineers (collectively “the Builders”), designed and built the
house. Hanna moved into the structure in September 2010 and
closed on the home purchase that December.
At some point before the closing, Lamp and Innovative
enrolled Hanna’s home in a 2-10 Home Owners Warranty (the “2-10
Warranty”) offered by the Home Buyers Warranty Corporation, the
National Home Insurance Company, and the New Home Warranty
Insurance Company (collectively “the Warranty Companies”). The
2-10 Warranty offered nearly identical protection as the
Builder’s Warranty: one year on the home’s workmanship, two
years on its systems, and ten years on its structure. The 2-10
Warranty also contained something that the Builder’s Warranty
did not: an arbitration clause. It stated, in relevant part:
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Any and all claims, disputes and controversies by or
between the owner, the Builder/Seller, the Warranty
Insurer and/or [Home Buyers Warranty Corporation], or
any combination of the foregoing, arising from or
related to this Warranty, shall be settled by binding
arbitration. . . . Any person in contractual privity
with the Builder/Seller whom the Home owner contends
is responsible for any construction defect in the Home
shall be entitled to enforce this arbitration
agreement. . . . The decision of the arbitrator shall
be final and binding and may be entered as a judgment
in any State or Federal court of competent
jurisdiction.
J.A. 17 (boldface type omitted).
The 2-10 Warranty states that it was issued pursuant to a
“Builder Application for Home Enrollment,” a document Hanna had
purportedly “signed with [her] Builder.” J.A. 143. Hanna
contends that she signed no such document and no application for
enrollment appears in the present record. Additionally, the
record contains no evidence that Hanna authorized Lamp and
Innovative to enroll her home in the 2-10 Warranty. Hanna
admits that she first heard that her home had been enrolled in
the 2-10 Warranty in the fall of 2010, but contends that she did
not learn about the arbitration clause until documents were
mailed to her in February 2011, after the closing on her new
house.
B.
Hanna came to believe that her home contained a number of
defects and notified Lamp and Innovative, who then filed a claim
with the Warranty Companies in November 2011. Hanna was not
4
satisfied with the response of Lamp, Innovative, the Warranty
Companies, or the two additional entities involved in the
adjustment of her warranty claims (the “Claims Adjusters”).
Therefore, on November 27, 2012, she filed suit in West Virginia
state court against the Builders, Warranty Companies, and Claims
Adjusters. See Hanna v. Innovative Design & Construction, LLC,
Circuit Court of Kanawha County, West Virginia, Case No. 12-C-
2358. Hanna currently advances seven counts in that suit: “(1)
negligence in the construction of the home; (2) breach of the
construction contract, addenda, covenants and builder’s warranty
associated with the construction of the home; (3) breach of
implied warranties of habitability and merchantability; (4)
breach of the [2-10 Warranty]; (5) bad faith denial of Hanna’s
benefits under the [2-10 Warranty]; (6) fraud and
misrepresentation with respect to the [2-10 Warranty]; and (7)
punitive damages.” J.A. 321. All of her claims arise from
state law.
Furthermore, Hanna contends that the arbitration provision
in the 2-10 Warranty is unenforceable on various state law
grounds. The Warranty Companies indicated in their federal
petition that they intended to “plead arbitration as an
affirmative defense” to Hanna’s state court claims, J.A. 8, and
their counsel confirmed at oral argument before this court that
they have done so.
5
C.
On February 1, 2013, the Warranty Companies filed a
Petition to Compel Arbitration before the U.S. District Court
for the Southern District of West Virginia. In the petition
they asked the district court to order Hanna to arbitrate her
claims against them based on the arbitration clause in the 2-10
Warranty and to stay the state court proceedings against them
while the arbitration was pending. The Warranty Companies
predicated their petition on diversity jurisdiction under 28
U.S.C. § 1332. None of the Builders were joined as parties.
Hanna filed a Motion to Dismiss on April 5, arguing that
the district court lacked subject matter jurisdiction because
the entire controversy underlying the petition included non-
diverse parties. In the alternative, she argued that the case
had to be dismissed because those same non-diverse parties were
necessary and indispensable parties that the Warranty Companies
failed to join under Rule 19 of the Federal Rules of Civil
Procedure. Hanna noted that, although the Warranty Companies
are foreign corporations for diversity purposes, she shared West
Virginia citizenship with Lamp, Innovative, and at least three
of the other Builders.
The Warranty Companies contended that the parties to the
petition were diverse and that the Federal Arbitration Act
(“FAA”) and Moses H. Cone Memorial Hospital v. Mercury
6
Construction Corp., 460 U.S. 1 (1983), established that the co-
defendants in the state court action need not be joined as
parties. They also requested that the district court exercise
its power under 28 U.S.C. § 2283 to halt the state court
proceedings against them.
On June 10, the district court abstained under Colorado
River Water Conservation District v. United States, 424 U.S. 800(1976), from ruling on the merits of the petition to compel
arbitration. The district court weighed the various Colorado
River factors bearing upon abstention, ultimately concluding
that it had “no reason to doubt the petitioners’ ability to
pursue their rights in the state court system” and that it could
not “find that the arbitration issue can only be resolved
efficiently in this court.” J.A. 325. The lower court did not
address the parties’ arguments on subject matter jurisdiction
and simply ordered the petition dismissed. The Warranty
Companies thereafter filed this timely appeal.
II.
We first consider the threshold issue of subject matter
jurisdiction. The Warranty Companies contend that the district
court has subject matter jurisdiction, that it erred in
declining to exercise jurisdiction over their petition under the
Colorado River abstention doctrine, and that the arbitration
7
clause is enforceable against Hanna. We do not reach the
questions of abstention or enforceability because we find that
the district court lacked subject matter jurisdiction. Because
it is a question of law, we review de novo whether such
jurisdiction exists. Trans Energy, Inc. v. EQT Prod. Co., 743
F.3d 895, 900 (4th Cir. 2014).
Fundamental to our federal system is the principle that
“[f]ederal courts are courts of limited jurisdiction.” Kokkonen
v. Guardian Life Ins. Co. of Am., 511 U.S. 375, 377 (1994).
District courts may only hear a case when they possess the
“power authorized by Constitution and statute.” Exxon Mobil
Corp. v. Allapattah Servs., Inc., 545 U.S. 546, 552 (2005)
(internal quotation marks omitted). When a party desires to
proceed in a federal court, it “must allege and, when
challenged, must demonstrate the federal court’s jurisdiction
over the matter.” Strawn v. AT & T Mobility LLC, 530 F.3d 293,
296 (4th Cir. 2008). For if Congress has not empowered the
federal judiciary to hear a matter, then the case must be
dismissed.
The Warranty Companies argue that the district court has
subject matter jurisdiction on two grounds: diversity of
citizenship under 28 U.S.C. § 1332 and the FAA, 9 U.S.C. § 4.
It is well established that § 4 does not create federal
jurisdiction, but applies only when “diversity of citizenship or
8
some other independent basis for federal jurisdiction” exists.
Moses H. Cone Mem’l Hosp. v. Mercury Constr. Corp., 460 U.S. 1,
25 n. 32 (1983). Thus, the only potential source of
jurisdiction for the Warranty Companies’ petition is the
diversity of the parties.
And of course under § 1332 that diversity must be complete
“such that the state of citizenship of each plaintiff must be
different from that of each defendant.” Athena Automotive, Inc.
v. DiGregorio, 166 F.3d 288, 290 (4th Cir. 1999). Hanna, as a
citizen of West Virginia, does not dispute that the Warranty
Companies are completely diverse from her. Rather, she
maintains that the Warranty Companies have failed to include as
necessary and indispensable parties the Builders, some of which
are also citizens of West Virginia. See Northport Health Servs.
of Ark., LLC v. Rutherford, 605 F.3d 483, 486 (8th Cir. 2010)
(“[D]iversity of citizenship is determined by reference to the
parties named in the proceeding before the district court, as
well as any indispensable parties who must be joined pursuant to
Rule 19.”) (internal quotation marks omitted). 1
1
Hanna also argues that under Vaden v. Discover Bank, 556
U.S. 49, 62 (2009), we may “look through” the petition to compel
arbitration to the underlying dispute in state court to
ascertain whether it contains non-diverse parties. Because we
determine that the Builders are necessary and indispensable
parties under Rule 19, we need not address whether Vaden applies
to petitions predicated on diversity jurisdiction.
9
A.
Rule 19 of the Federal Rules of Civil Procedure sets forth
a two-step inquiry for courts to determine whether a party is
“necessary” and “indispensable.” The first question under Rule
19(a) is “whether a party is necessary to a proceeding because
of its relationship to the matter under consideration.”
Teamsters Local Union No. 171 v. Keal Driveaway Co., 173 F.3d
915, 917 (4th Cir. 1999). Second, if the party is necessary but
joining it to the action would destroy complete diversity, the
court must decide under Rule 19(b) “whether the proceeding can
continue in that party’s absence.” Id. at 917-18.
Rule 19 is not to be applied as a “procedural formula.”
Provident Tradesmens Bank & Trust Co. v. Patterson, 390 U.S.
102, 119 n. 16 (1968). Decisions “must be made pragmatically,
in the context of the ‘substance’ of each case,” id., and courts
must take into account the possible prejudice “to all parties,
including those not before it,” Owens-Illinois, Inc. v. Meade,
186 F.3d 435, 441 (4th Cir. 1999). While the dismissal of a
case is a “drastic remedy [that] should be employed only
sparingly,” it is required if a non-joined party to the dispute
is both necessary and indispensable. Keal, 173 F.3d at 918.
Here, as indicated in Owens-Illinois, 186 F.3d at 441-42,
the relevant dispute (and hence the primary focus of necessary
and indispensable party analysis) is the dispute over
10
arbitrability and the need generated by the 2-10 Warranty
arbitration clause for the Builders to be in the courtroom. See
also Doctor’s Assocs., Inc. v. Distajo, 66 F.3d 438, 446 (2d
Cir. 1995). 2
1.
The first stage of our inquiry focuses on whether there
were necessary parties not joined in the petition. A party
might be necessary under either Rule 19(a)(1)(A) or (B). We
begin here with Rule 19(a)(1)(B), which provides that a non-
joined party is necessary to an adjudication if it “claims an
interest relating to the subject of the action” and its absence
would either conflict with its “ability to protect the
interest,” Rule 19(a)(1)(B)(i), or “leave an existing party
subject to substantial risk of incurring . . . inconsistent
obligations because of the interest,” Rule 19(a)(1)(B)(ii).
Each of these criteria requires that we attempt to forecast the
future course of this litigation, which of course is no simple
matter. However, there are enough potentially prejudicial
outcomes under either of these standards to warrant the
conclusion that the Builders are necessary parties.
2
We do not read Owens-Illinois as in tension with Ranger
Fuel Corp. v. Youghiogheny & Ohio Coal Co., 677 F.2d 378 (4th
Cir. 1982), which, while discussing the merits dispute, avoided
any definitive resolution of the question.
11
Rule 19(a)(1)(B)(i) directs us to consider a non-joined
party’s ability to protect its own interests. The Builders have
a direct pecuniary interest in the dispute through the 2-10
Warranty; indeed, they are actively contesting their liability
in state court with respect to Hanna’s claims against them under
that contract. The Warranty Companies seek arbitration of
identical claims. Hanna is also suing the Builders in tort;
several of her tort claims likewise reference the 2-10 Warranty
provisions. Although joint tortfeasors from a state court
proceeding are not automatically necessary parties to a federal
case under Rule 19, Northport, 605 F.3d at 490-91, the Builders’
interest in this case extends even beyond the possibility of
tort liability. The 2-10 Warranty obligates the Warranty
Companies to insure the Builders’ liability for construction
defects like those alleged by Hanna, giving the Builders a
natural interest in any adjudication of the terms of that
contract. See Ranger Fuel Corp. v. Youghiogheny & Ohio Coal
Co., 677 F.2d 378, 379 (4th Cir. 1982).
Furthermore, Lamp and Innovative are critical to the
question of whether or not the arbitration clause is enforceable
in the first place. Hanna alleges that she did not consent to
arbitration and never authorized Lamp and Innovative to agree to
an arbitration clause on her behalf. See Stolt-Nielsen S.A. v.
AnimalFeeds Int’l Corp., 559 U.S. 662, 684 (2010) (holding that
12
a “foundational FAA principle [is] that arbitration is a matter
of consent”). Thus, the outcome of the petition could very well
turn on a determination of whether Lamp’s and Innovative’s
enrollment of Hanna’s home in the 2-10 Warranty was consensual
and legally binding on Hanna. Such a ruling could have a
significant impact on the Builders’ potential liability before
the state court. While the Warranty Companies contend that Lamp
and Innovative could simply serve as fact witnesses, fairness
requires that Lamp and Innovative be joined as necessary parties
to protect their own interests in the determination of the legal
significance of their actions. See Nat’l Union Fire Ins. Co. v.
Rite Aid of S.C., Inc., 210 F.3d 246, 251-52 (4th Cir. 2000).
Rule 19(a)(1)(B)(ii) is a separate basis for finding a non-
joined party necessary and protects the existing parties to the
action from “incurring . . . otherwise inconsistent obligations
because of the [non-joined party’s] interest.” The existence of
two concurrent proceedings here creates a “high likelihood” that
one or more of the parties will be subject to conflicting
obligations. Owens-Illinois, 186 F.3d at 441. If the Warranty
Companies’ petition is allowed to proceed, the district court
will be required to determine whether the arbitration clause is
enforceable and, because the Builders are entitled to demand
arbitration under the provision, the state court may be faced
with the same task. One court could enforce the arbitration
13
clause while another finds it unenforceable. See id. (holding
that risk of inconsistent interpretations of arbitration clause
by different tribunals merited adjudication of entire case
before one court).
Unlike in this petition, the Builders (and all others) are
present as parties before the state court. That court is thus
better positioned to take into account the Builders’ interests.
Moreover, it is undeniable that adding a federal court, and any
arbitration panel it might compel, to the equation multiplies
the tribunals adjudicating the dispute and thereby increases the
likelihood of contradictory rulings. Where possible, law should
be utilized to streamline and simplify. We decline to impose
added expense and complexity upon these litigants, when there
are no good reasons sounding in the fair or efficient
administration of justice to do so. See Ranger Fuel, 677 F.2d
at 380 (rejecting district court’s order that had effect of
“multiplying procedures that might lead to inconsistent
results”).
Finally, Rule 19(a)(1)(A) sets forth another necessity
standard, stating that a non-joined party is necessary when “the
court cannot accord complete relief among existing parties.”
The above discussion concerning the “overarching legal and
factual issues” makes it clear that any tribunal to address this
matter must have the Builders present as parties to fully
14
resolve the dispute arising from the alleged construction
defects in Hanna’s home. Schlumberger Indus., Inc. v. Nat’l
Sur. Corp., 36 F.3d 1274, 1287 (4th Cir. 1994). If Hanna is
entitled to full recovery on the defects in her house, then it
is crucial that all of the defendants be bound to the burdens of
a common judgment. See id. at 1286 (finding prejudicial that
failure to join insurers as parties would potentially cause
existing party to “wind up with less than full coverage even
though it was legally entitled to full coverage”) (emphasis
omitted). Therefore, the Builders are necessary parties under
the criteria of Rule 19.
2.
Several of the Builders are citizens of West Virginia and
would destroy complete diversity if joined. We must thus decide
whether they are “indispensable” to the proceeding. Rule 19(b)
provides that if a necessary party cannot be joined without
destroying jurisdiction “the court must determine whether, in
equity and good conscience, the action should proceed among the
existing parties or should be dismissed.” In light of the four
factors contained in Rule 19(b), we conclude that the Builders
are indispensable parties.
The first factor addresses “the extent to which a judgment
rendered in the [non-joined party’s] absence might prejudice the
parties.” Owens-Illinois, 186 F.3d at 441. This factor speaks
15
to many of the same concerns addressed by the necessity analysis
under Rule 19(a)(1)(B). Keal, 173 F.3d at 919. As discussed
above, there is a high probability of prejudice to the Builders
if the petition advances. That is especially true for Lamp and
Innovative, as they are allegedly responsible for enrolling
Hanna in the 2-10 Warranty. See Nat’l Union, 210 F.3d at 252-53(finding under first factor that prejudice to non-joined party
was “particularly strong given that [it] negotiated and entered
into the [insurance] policy, and this suit concerns [its]
conduct”). Hanna also has a powerful interest in having all of
the defendants together and adjudicating all of her claims
before one tribunal.
The second factor considers the extent to which protective
measures can be taken to lessen or avoid the prejudicial impact
of proceeding in the non-joined party’s absence. Here, it is
not clear how the district court could do so. Different
tribunals might be required to rule on the validity of the
arbitration provision and each must address the existence and
extent of construction defects in Hanna’s home, which could
result in inconsistent judgments and conflicting obligations on
the parties. The Warranty Companies do not suggest how the
court might head off such confusion, and the prospect of
prejudice from parallel proceedings is thus substantial. See
Keal, 173 F.3d at 919.
16
The third factor addresses the adequacy of a judgment
rendered in the non-joining party’s absence, which focuses on
“the interest of the courts and the public in complete,
consistent, and efficient settlement of controversies.”
Provident Bank, 390 U.S. at 111. Here the parallel proceedings
could produce just the opposite: incomplete, inconsistent, and
inefficient rulings. Thus this factor also points to the
Builders as indispensable parties in the proceedings. See Nat’l
Union, 210 F.3d at 253.
Under the fourth factor we consider whether the petitioners
“would have an adequate remedy if the action were dismissed for
nonjoinder.” Fed. R. Civ. P. 19(b)(4). Of course they would.
The state court is entirely capable of adjudicating this
dispute. All of the necessary parties are joined in that forum.
The suit arises wholly from state law and, in the event it goes
to trial, the witnesses and exhibits common to Hanna’s claims
against all the co-defendants are readily available. Owens-
Illinois, 186 F.3d at 442. Furthermore, Hanna and the Warranty
Companies have already begun to address the validity of the
arbitration clause in the state court and “[u]nder the FAA,
state courts as well as federal courts are obliged to honor and
enforce agreements to arbitrate.” Vaden v. Discover Bank, 556
U.S. 49, 71 (2009). “[W]e see no reason why the Circuit Court
of Kanawha County, West Virginia will not provide an adequate
17
remedy for the parties in this case.” Owens-Illinois, 186 F.3d
at 442.
All four Rule 19(b) factors point to the Builders being
indispensable to the petition. Because the Builders are both
necessary and indispensable, the petition must be dismissed for
lack of subject matter jurisdiction.
B.
A final point, however, is critical. The Warranty
Companies argue that the FAA’s policy in favor of arbitration
agreements means they are due a federal forum for their
arbitrability claim. While the strong federal policy favoring
enforcement of arbitration agreements is clear, it does not
establish subject matter jurisdiction here.
The FAA was adopted by Congress in 1925 in an effort to
“shift [courts] from an attitude of inveterate hostility toward
arbitration agreements to one strongly favoring arbitration and
encouraging the rigorous enforcement of all arbitration
agreements.” Glass v. Kidder Peabody & Co., 114 F.3d 446, 451
(4th Cir. 1997). The Supreme Court recognized this
transformation in Moses H. Cone when it applied the “liberal
federal policy favoring arbitration agreements” to overturn a
district court’s decision to abstain from exercising
jurisdiction over a case under the Colorado River doctrine. 460
U.S. 1, 24, 29 (1983).
18
The Warranty Companies contend that Moses H. Cone requires
the district court to take subject matter jurisdiction over this
petition. But unlike in the case before us, there was no
question in Moses H. Cone that all the necessary and
indispensable parties were joined in the petition to compel
arbitration. Moses H. Cone thus did not address subject matter
jurisdiction or Rule 19 joinder; instead, it applied only to a
federal court’s decision to abstain from exercising pre-existing
jurisdiction. Id. at 25-26 (“[W]e emphasize that our task in
cases such as this is not to find some substantial reason for
the exercise of federal jurisdiction by the district court;
rather, the task is to ascertain whether there exist
‘exceptional’ circumstances, the ‘clearest of justifications,’
that can suffice under Colorado River to justify the surrender
of that jurisdiction.”). Indeed, Moses H. Cone reaffirmed that
the FAA does not provide an independent basis of subject matter
jurisdiction. Id. at 25 n. 32. And while federal courts have a
“virtually unflagging obligation . . . to exercise the
jurisdiction given them,” that does not imply a federal court
may assert jurisdiction where it is not congressionally
authorized. Id. at 15 (internal quotation marks omitted).
This makes perfect sense. The FAA applies with as much
force in state courts as in federal. Id. at 25; see also KPMG
LLP v. Cocchi, 132 S. Ct. 23, 24 (2011) (per curiam)
19
(recognizing that arbitration agreements “within the scope and
coverage” of the FAA “must be enforced in state and federal
courts”). That is not to say, of course, that federal courts
lack jurisdiction for all petitions under § 4 of the FAA
whenever they involve a subset of diverse parties to a state
court proceeding that also includes non-diverse parties. All it
means is that, although the FAA clearly favors the enforcement
of arbitration agreements as a general matter, there is no
obvious reason why that policy must be vindicated in a federal
over a state forum. Moses H. Cone, 460 U.S. at 25 n. 32 (noting
that “enforcement of the [FAA] is left in large part to the
state courts”). In sum, Moses H. Cone and the undisputed
interest in honoring arbitration agreements does nothing to
undermine our conclusion that subject matter jurisdiction is
lacking here.
III.
For the foregoing reasons we hold that the petition of the
Warranty Companies cannot proceed in federal court because the
joinder of necessary and indispensable parties would extinguish
the power of the court to hear the case. The petition is hereby
remanded to the district court with directions to dismiss it for
want of subject matter jurisdiction.
REMANDED WITH DIRECTIONS
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